About the blog
The BCC blog is a space of exchange among BCC stakeholders about topics of interest in the realm of central banking. It offers a space where latest trends can be discussed, practical experiences be shared, and a BCC community be developed.
The BCC programme, funded by SECO and implemented by The Graduate Institute, Geneva aims to support partner central banks in emerging countries in building the analytical and technical expertise to conduct effective monetary policy, promote stable and efficient financial sector, and be more operationally sustainable.
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How does climate change impact the financial stability policy of the Central Bank of Tunisia? by Nacef Abdennadher, Dr & Ramzi Salem
Nacef ABDENNADHER, Dr & Ramzi SALEM Banque Centrale de Tunisie
Climate change is seen as a major long term shock affecting the world economy. Climate change is a multidimensional threat that affects all the aspects of human life such as food security, migration, physical capital losses and thus, financial stability. The issue is even more challenging for the developing countries.
Many papers have documented the relationship between climate change and economic activity, and we can confidently say that the impact is significantly negative and requires policy action. At the same time, a precise assessment remains difficult because of many complexities and uncertainties, in part because of the long term aspect of the issue. Policies should involve many stakeholders (governments, civil society, firms, Central Bank) and are multidimensional (environmental, fiscal, monetary and macroprudential).
Within the range of policies aimed at dealing with climate change, central banks can be tasked to mitigate the impact on financial stability come from the many constraints driven by environmental change. Specifically, it threatens financial stability via 3 channels: physical risk, transition risk and liability risk. Physical risk reflects the frequency and magnitude of extreme weather events (storms, heavy rain, flooding, drought and associated wildfires, and heat waves) that are increasingly unpredictable. Transition risk is linked to the timing of measures implemented to reduce CO2 emissions, as governments can in some cases introduce very high taxes and customs tariffs on certain industries, equipment or raw materials. Borrowers operating in the sectors most targeted by the new taxes and measures would see the value of their assets decline and may not be able to repay their loans. Liability risk is the possibility that a party can be held responsible for certain types of losses. Many businesses face various types of liability risk, leading to losses which can be quite substantial. Liability coverage is therefore extremely important for these companies. The most exposed agents to climate change financial risk are banks and insurers.
Tunisia is conscious about climate change risks and has integrated environment protection in the 2014 constitution. As a member of the “Paris agreement”, Tunisia submitted his first Nationally Determined Contribution (NDC) in September 2015. In 2020, Tunisian NDC updated, Adoption of the National Strategy of low Carbon.
In parallel, the Tunisian Financial sector has subscribed to the environment protection and in 2019, the Central Bank of Tunisia became member in the Network of Central Banks and Supervisors for the Greening of Financial System (NGFS).
Some Tunisian banks have started to apply rules in line with international practices in terms of green finance. However, the financing of the ambitious objectives for the energy transition, the horizon of which extends to 2030, should require a consolidation of the efforts of financial institutions in terms of financing and support.
The central bank of Tunisia is in the process of establishing a CSR strategy, in which it will certainly put its capacities and skills in order to develop and make available to the banking system financing means and standards which should accelerate the pace of the energy transition.
 The NDC traces the commitment of a given country to introduce renewable energy in all energy production until a given share is reached, reduce primary energy demand to a target threshold and reduce carbon emissions to a desired level.
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In addition to causing a global recession, the COVID-19 pandemic, spurred a dramatic response in capital markets (Alfaro et al., 2020; De Bock et al., 2020). As investors gauged the economic consequences of the pandemic and the subsequent policy responses, they initiated a wave of capital reallocation between markets and asset classes.
Using high-frequency weekly data of country-level portfolio flows, Figure 1 puts the impact of the pandemic in perspective with other events by showing the cross-sectional distribution of portfolio flows across countries on selected dates, with a net pullback by investors corresponding to densities that are more to the left. The global shift in international portfolio flows was of historically large magnitude and countries' experience at the height of the episode differed widely. This heterogeneity suggests that domestic pull factors have played an important role, both directly and indirectly via their impact on countries' sensitivity to the global shock.
Figure 1 Densities of portfolio flows (percent of allocation)
In a recent paper (ElFayoumi and Hengge, 2020), we examine if and how the number of domestic infections, the stringency of lockdown measures, and the fiscal and monetary policy response determined the magnitude of portfolio flows and market-implied sovereign risk during the COVID-19 pandemic. In addition, we explore three sources of heterogeneity: market development (emerging (EMs) vs. developed markets (DMs)), asset classes (bonds vs. equities), and investors’ domicile (foreign vs. domestic).
Overall, our findings demonstrate that capital market dynamics were not exclusively driven by undiscriminating global factors. Instead, the severity of the pandemic at the domestic level and governments’ policy responses played a role in explaining the heterogeneity of portfolio flows and sovereign risk across countries during the COVID episode.
Effect of infections and policy responses on capital markets
We build a panel dataset for 37 emerging and developed markets, with weekly information on the number of new COVID cases, the stringency of governments’ lockdown, and the fiscal and monetary policy response. Figure 2 summarizes the heterogeneity across countries’ experience of the virus and their policy responses. We match these data with weekly portfolio flows from EPFR and spreads of sovereign credit default swaps (CDS).
Figure 2 Heterogeneity in COVID cases and policy responses
Our empirical approach relies on local projections (Jordà, 2005) to estimate both the contemporaneous and the cumulative response of flows to shocks over a one-month horizon. For identification, we rely on the high frequency of the data and the efficiency by which investors’ portfolios adjust to new market information. Both elements, as we discuss extensively in the paper, allow us to overcome the inherent endogeneity between the spread of the virus, policy actions, and market outcomes.
We find that the domestic spread of the virus led to a cumulative increase in total net portfolio flows in EMs. This increase was associated with a reallocation towards safer assets as equity holdings declined and bond flows rose. Sovereign CDS spreads increased, suggesting that the increase in net portfolio flows was driven by demand for liquidity, potentially reflecting widening financing needs to mitigate the fallout from the pandemic.
Our analysis also shows that, following an initial negative response, a more stringent lockdown led to larger net portfolio flows over the one-month horizon in EMs. Similarly, governments' efforts to provide fiscal stimulus were successful in supporting higher portfolio flows to the domestic economy. Unlike the case for COVID infections, evidence from the CDS market suggests that the increase in flows was dominated by supply forces, reflecting investors’ preference for stronger policy responses.
With respect to monetary policy, we do not find a significant contemporaneous impact of a rate cut on portfolio flows in EMs. Yet, in DMs, they triggered an increase in net portfolio flows upon impact as central bank actions provided reassurance to markets, stimulating flows to the domestic economy. Over the horizon of a month, however, we find that monetary policy cuts led to a decline in net portfolio flows both in EMs and DMs, as expected by the interest rate parity and search for yield channels. Figure 3 shows the dynamic response of total portfolio flows to shocks to the domestic COVID factors.
Figure 3 Impact of domestic COVID cases and policy response on total net portfolio flows
Policy measures and the global shock
In addition to their direct effect, domestic policy measures can also impact the dynamics of portfolio flows by mitigating or exacerbating the impact of the global shock. Our findings indicate that stricter lockdown measures and expansionary monetary policy actions helped mitigate the negative impact of the global shock on portfolio flows. In contrast, we find that larger fiscal stimulus exacerbated the impact of the global shock cumulatively, despite an initial positive effect.
Historical contribution of domestic COVID factors and global shocks
Notwithstanding the significant and sizeable role of domestic COVID factors, a historical decomposition analysis suggests that global factors played the larger role in explaining portfolio flow movements during the COVID episode. Their effect was negative and orders of magnitude larger in comparison to the COVID-related domestic factors, especially during the early and most uncertain phase of the pandemic. The large difference in magnitude between global and domestic COVID factors suggests that other county-specific policy and institutional factors were responsible for why the net historical effect on portfolio flows in EMs was not as negative as the estimated contribution of the global shock during the pandemic would suggest.
Authors’ note: The views expressed are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Alfaro, Laura, Anusha Chari, Andrew Greenland, and Peter K. Scott (2020). Covid Economics: Vetted and Real-Time Papers, 4, pp. 2-24.
Avdjiev, Stefan, Leonardo Gambacorta, Linda S. Goldberg, and Stefano Schiaffi (2020). The shifting drivers of global liquidity. Journal of International Economics, 125, pp. 103324.
De Bock, Reinout, Dimitris Drakopoulos, Rohit Goel, Lucyna Gornicka, Evan Papageorgiou, Patrick Schneider, and Can Sever (2020). Managing volatile capital flows in emerging and frontier markets. VoxEU.org, 19 August.
ElFayoumi, Khalid and Martina Hengge (2020). Capital Markets, COVID-19 and Policy Measures. Covid Economics: Vetted and Real-Time Papers, 45, pp. 32-64.
Fratzscher, Marcel (2012). Capital flows, push versus pull factors and the global financial crisis. Journal of International Economics, 88(2), pp. 341-356.
Gilchrist, Simon and Zakrajšek, Egon (2012). Credit spreads and business cycle fluctuations. American Economic Review, 102(4), pp.1692-1720.
Jordà, Òscar (2005). Estimation and inference of impulse responses by local projections. American Economic Review, 95(1), pp. 161182.
Rey, Hélène (2015). Dilemma not trilemma: the global financial cycle and monetary policy independence. National Burau of Economic Research.
1 An earlier version of this blog was published on VoxEU.org.
2 The analysis focuses on the domestic component of these variables, while controlling for global factors.
3 Total net portfolio flows are defined as the net value of purchases and redemptions of bond and equity funds.
4 Combined, information about the quantity (flows) and price (CDS spreads and stock prices) of assets provides an identification of the supply and demand channels of portfolio flows. To the extent that these two measures are tightly linked by market forces, shifts in supply are associated with changes in flows and spreads in opposite directions, whereas shifts in demand move both variables in the same direction. This intuition is in line with Gilchrist and Zakrajšek (2012) who study the relative contribution of credit supply and demand factors in corporate bonds.
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Emina Milišić, Office of Chief Economist Central Bank of Bosnia and Herzegovina
Interacting with International Financial Institutions is of great importance, especially for Central Banks, which often engage and take decisions on which the further path of an economy depends. Gaining a solid knowledge of the negotiation process, as well as experience in conducting negotiations, is crucial for the staff members who are responsible for such processes. In this blog post, I share some of the reflections I’ve made after participating at the BCC online course on interacting with International Financial Institutions.
Prepare yourself and your team
Preparation is the most important step in the process. Negotiators often fail to make an agreement or derive maximum benefit from their negotiation because one or both sides did not prepare effectively. It is very important that each team first prepare internally in order to establish objectives, define responsibilities, analyze threats, and review contingency plans. During the negotiation process it is very important that we trust each member of our team. Team members should understand their responsibilities fully, and any tasks assigned to them.
Have clear objectives: What are you trying to achieve? What are the objectives, and why?
In preparing for any negotiation, you must first of all determine your goals. What do you want from the negotiation? It is crucial that we fully understand all the issues that might arise from both parties. To prepare, you need to rely on intelligence, knowledge, but also research. It is one thing to prepare for negotiation within our own country with different domestic policy institutions, it is entirely different when we negotiate with an altogether different culture. It is crucial to gain as much understanding about the tactics of the other side and be prepared. If we don’t prepare wisely beforehand, we’re more likely to encounter a misunderstanding.
Make yourself and your position understood
Your goal is to make yourself and your position understood, and this relies on your communication ability. If one team fails to listen intently to the other team, negotiations could stall or become unproductive. During a negotiation process, all parties should speak directly to each other and should be prepared to explain problems, articulate shared and unshared interests and work together toward a fast resolution. Effective communication comes down to being prepared to listen to and respect the other person's point of view and to make other person understand yours. For this, you need to communicate in a way that makes the other person want to listen. While it may sound basic to say that communicating effectively (both listening and talking) is crucial for an effective negotiation, it is however essential: in a negotiation so as to leave little room for communication breakdowns and misunderstandings.
Negotiation leads to compromise? - Your and the other side’s options
Last but not least, sometimes the key to success is to be willing to compromise on less important things in order to reach your main goal. Understand that the push-back you’re getting is just an opportunity to problem-solve in a way that satisfies your interests and the other party’s interests at the same time.
Conclusion - Don't be afraid to ask for what you want
Negotiation ability is something that can always be worked on and refined. Proper preparation is a source of negotiating power because it enhances your ability to persuade the other side to agree to what you are asking for. International negotiations -especially in the framework of the Central Banks- must be understood as a continuous process with preparatory meetings in various regions of the world, with pre-, main-, and post-negotiations. Across these steps, the power relations can take different forms, shaping the final outcomes. Moreover, the result of the negotiation will also depend on the type of relationships that exists between the negotiating parties.
Negotiation is best learned through practice. This is why I think that the exercises we had during the course really gave a completely new perspective and new experiences that will mean a lot for our future negotiations that we will encounter in life.
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The coronavirus pandemic is like nothing that has been seen globally for over 100 years. Organizations, their employees and the general public have completely revised how they live and work. We know that this pandemic will be with us until there are widespread and easily available vaccines, therapeutics and herd immunity. Normally any activation of the crisis management team leads to an after-action report. Given the lengthy duration of the coronavirus pandemic, it is important to stop and do periodic assessments. If you haven’t done an interim after-action report yet, this is a great time to do one!
The technical online workshop organized by the BCC programme on December 2-4 provided an opportunity for the participating central banks to share experiences and conduct such an assessment. Here is a short list of some of the things which experience has shown to improve organizations performance:
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In a challenging time for the world, the BCC programme sponsored a web-workshop on business continuity planning in the light of the COVID-19 outbreak where representatives from associated central banks met to explore solutions and share experiences in light of the pandemic.
The workshop gave participants the opportunity to share their experiences on strategies and practices related to the impacts of the pandemic on daily operations and to discuss resulting transitory and permanent changes.
During the webinar from December 2 to 4 2020 group members discussed the theme with the help of two moderators, one specialist with experience with central banks and another one from the private sector.
The conference started with an overall view of the pandemics and the importance of a well designed crisis management framework. Participants then were separated in groups for discussions on several themes. After the debate a member of the group shared their thoughts and experiences with all participants.
On the first day of the conference two topics were explored. The first was the aspect of teleworking and its related subjects of home-office experiences, cybersecurity threats, legal and administrative implications of this new environment and staff motivation and efficiency in a situation with less strict internal controls. The focus was on sharing which procedures and practices worked and what needed more studies or even an overhaul.
The second topic covered how to handle a simultaneous crisis event. Usually business continuity planning is designed to handle a single source of disruption and all strategies to handle the situation are planned within this framework. However, due to the long timespan of the pandemic, it is possible, or even likely, that another adverse event, such a natural event (fire, earthquake etc) can happen simultaneously. In light of this problem participants discussed their thoughts on challenges and opportunities related with their plans and resources likely available.
On the second day of the conference participants first discussed occupational safety and health at the workplace where participants discussed about office preparation procedures, control and prevention of the disease, standards followed by the institutions involved and how alerts were sent to employees. Participants then discussed governance and strategy. This topic generated a lot of experience sharing on roles and responsibilities, situational awareness, impact on operational risk assessment and use of risk information, business continuity planning and culture and finally lessons learnt in this new pandemic experience.
The last day was dedicated to a broader view of the problem. Participants were presented with detailed information on the pandemics, vaccines and technology involved, expected evolutions of the situation and how to handle impacts on mental health and other aspects of human behavior.
The conference was successful and saw intense participation of members who actively shared their experiences. Each central bank came back with some new thoughts and a review or reassuring of their practices on the demanding situation we live today.
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Towards a framework for supervising and measuring climate-related financial stability risks in Colombia - by Daniel Osorio
Daniel Osorio, Head of Financial Stability at the Banco de la República (Central Bank of Colombia)
The reality of climate change is already presenting new challenges to policymakers around the world. The gradual, cumulative effect of structurally different weather patterns, such as more extreme temperatures or changes in rainfall intensity, is already having (in some cases devastating) consequences on the performance of local economies and financial markets.
In terms of financial stability, there seems to be a wide consensus with regard to the most important sources of risks created by climate change. One may argue that these risks underlie any structural change in economic performance, not only those caused by climate change. Indeed, transition risks are tightly linked to the role of the financial system as a vehicle for the reallocation of real resources; physical and liability risks relate to the role of the financial system as a tool for shock absorption. However, financial stability policy is especially affected (in the near future, perhaps determined) by climate change given the potentially gargantuan size of its cumulative effects.
Colombian financial authorities have acted to build the analytical foundations for the management of these risks, with the understanding that the exposure of the economy to climate shocks may be sufficiently high to warrant its own policy framework. The Financial Superintendence (in charge of supervision and wide swathes of regulation) has taken major steps as part of a multi-year strategy in: (i) establishing a common taxonomy of activities and instruments in close alignment with international standards; (ii) defining guidelines for the issuance and disclosure of green bonds with the aim of promoting transparency and market integrity; and (iii) using emerging tools to measure (and eventually divulge) climate-related financial risks.
The Central Bank has reinforced its research activity on the macroeconomic effects of climate change and the design of a climate stress test exercise, in order to assess the resilience of the domestic financial system to shocks arising from physical risks. The latter has become more important in light of recent evidence on the effects of more extreme “El Niño” and “La Niña” weather patterns on loan quality in Guatemala, with Colombia being worryingly exposed to the weather phenomenae. The Superintendence and the Bank recently joined the Network for Greening the Financial System (NGFS) in search of best practices to tackle the questions of how to manage climate risks in financial markets and how to incentivize a switch to a more sustainable financial system.
Looking ahead, it is clear that some features of the economy will irreversibly change as a consequence of the global pandemic. Policy action will help determine the speed and shape of this transition. In this context, policymakers across the world have a “window of opportunity” to engineer a ‘greener’ transition in which climate risks are adequately measured, supervised, managed, and ultimately, controlled.
 See Carney (2018) for a brief explanation of transition, physical and liability risks in this context.
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Belma Čolaković, Central bank of Bosnia and Herzegovina
Climate change is clearly a pressing issue in the modern world, and moves more like a trend, than a cycle. In this note I simplify reality greatly, and focus on transition risks, abstracting from uncertainty in the trajectory of country’s transition to a low carbon economy. In an environment of weak policy coordination and challenging structural developments, a monetary policy conducted while trying to include the transition risks of climate change could turn out to be suboptimal and lead to worse overall economic outcomes.
The Paris agreement vs Energy Trilemma
The Paris Agreement is a landmark environmental accord, currently ratified by all but seven countries in the world (with the USA in the procedure of withdrawing) to address climate change and its negative impacts. One of the goals is to become carbon neutral no later than the second half of this century. To achieve this, countries submitted carbon reduction targets prior to the Paris conference. These targets, among other things, outlined each country’s commitments for curbing emissions through 2025 or 2030. There are no specific requirements about how or how much countries should cut emissions. Conversely, national plans vary greatly in scope and ambition, largely reflecting each country’s capabilities, its level of development, and its contribution to emissions over time.
Environment sustainability is only one part of the, so called, energy trilemma. Every government is trying to reach three objectives: a) maximise the national capacity to meet current and future energy demand reliably, with minimum disruptions in supply (energy security); b) provide universal access to affordable, fairly priced and abundant energy for domestic and commercial use (energy equity), and; c) mitigate and avoid potential environmental harm. Figure 1 presents the World Energy Trilemma Index by each of three categories, as published in World Energy Council’s country rankings for 2020.
Figure 1: World Energy Council’s country rankings for 2020
Note: The scale represents country’s percentile ranking on all three ranks. Grade A are top 25% countries, so the closer the country to the origin, the higher the ranking. The number in the parentheses near the country code is country’s share in global CO2 emissions in 2018. Source: www.worldenergy.org and www.ourworldindata.org.
In 2018, just a couple of years after Bosnia and Herzegovina ratified the Paris agreement, Elektrorpivreda BiH (the largest public electric production company, part of a conglomerate with seven coal mines) launched a large capital investment project (worth EUR 722 million) for a new thermal plant. As part of the investment was financed by a credit line from abroad, the state government acted as the guarantor. The new thermal plant is designed to replace three existing blocks that will become outdated within the next five years, and its CO2 emissions will be in line with the current EU standards. On the other hand, this will certainly slow down the country's planned switch to a higher share of energy from the renewable sources. This illustrates the challenge for a government of respecting its obligations from the climate accord, while trying to secure energy independence over the next fifty years, thereby reducing risks to energy security and equity. There are also positive spillovers, such as the power from the electricity plant providing thermal energy for heating of the neighbouring towns, and continuation of the operations in the coal mines from the conglomerate.
Adjusting monetary policy to long term trends with uncertainty
Long run projections are tricky as we have very limited information on the responses and actions of other parties involved. Monetary policy is usually run in line with price stability while stabilizing GDP around its potential level. If transition climate risks are inappropriately accounted for in the potential GDP measure, a decrease in actual GDP generated by a supply shock, could be wrongly interpreted as a negative output gap and thus lead to expansionary monetary policy and an inflation that could be unnecessarily high in the short term.
Employment is a key indicator when monitoring economic activity. Extreme weather events can reduce employment because of the destruction of physical assets and the dislocation of people from the immediate vicinity of a disaster area. However, a transition risk can potentially change the sectoral composition of employment, leading to structural unemployment, which could be perceived by the public as a sign of ineffectiveness of monetary policy.
Finally, assessing the policy space will be challenging as central banks, typically, estimate the real rate of interest that is consistent with stable inflation when the economy is growing at full employment. The estimation of natural interest rate defines the policy stance (accommodative, neutral or restrictive), given a country’s position in the economic cycle. The potential impact of climate change on the natural interest rate is ambiguous. It might lower the rate as climate change might discourage labour supply, lower labour productivity, and shift age composition of population. It, however, may exert an upward pressure on the rate for countries attracting migration flows as climate change increases their labour supply.
What seems to be an appropriate course of action by one policy maker, can be seen as a whole different story when observing the cost and consequences of several policies implemented to deal with them and changes in the behaviour of economic agents. Actions perceived as ethically right, such as the calls for central banks to „do something“ about the climate change, in a way to alter the distribution of income and wealth, can be close to impossible to implement. The central bankers tend to focus more on the business cycle and not try to manage structural shifts that are not their forte.
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Quantitative easing, small firms, credit access and the real economy: Who benefits the most? - by Anne Kathrin Funk
Anne Kathrin Funk, Research Analyst in the Monetary Policy Strategy Division of the European Central Bank.
The views expressed here are those of the author and do not necessarily reflect those of the ECB or the Eurosystem.
In response to the Corona-crisis, the ECB announced its plan to purchase a very large additional amount of EUR 1.3 billion of private and public sector securities under the umbrella of the Pandemic Emergency Purchase Programme (PEPP). This comes in addition to the quantitative easing programme that the ECB has already been conducting since 2015, with the central bank having already accumulated EUR 2.3 billion worth of government bonds under the Public Sector Purchase Programme (PSPP). While there is ample evidence that the PSPP has been successful in lowering the long end of the yield curve, it is less clear whether the program improved credit access and funding conditions for the corporate sector, especially for small firms, and the extent to which affected the macroeconomy. The German constitutional court even argued that the ECB exceeds its mandate by conducting the PSPP (Bundesverfassungsgericht, 2020).
Small firms face more difficult financial access
In a recent study, I analyse the effects of the PSPP on credit access, employment, and investment for small and medium sized firms using firm-level data from the Survey on the Access to Finance of Enterprises (Funk, 2020). Small firms play an important role in the transmission of monetary policy to the real economy. They employ the majority of the labour force, but face more difficult access to finance and higher credit costs. My analysis estimates the effect of the ECB’s government bond purchases (measured as a share of the government bond market size) on a variety of indicators of credit access, as well as on employment and investment growth. The estimates control for credit demand, firm’s balance sheet characteristics and macroeconomic conditions.
Smaller firms in the periphery of the euro area benefit the most
The figure below shows the estimated impact on credit supply, credit availability, bank loan availability, financial constraints for credit and bank loans, the interest rate, employment and investment growth. The ECB’s PSPP improved credit access to small and medium sized firms. It is correlated with a higher availability of credit lines and bank loans, less financial constraints and lower interest rate charged on credit lines (see chart).
Effect of the PSPP on SMEs’ credit access, employment and investment growth
Notes: The figure illustrates estimated effect of the PSPP as share of government bond market size on SMEs’ credit access as well as employment and investment growth. Credit supply, credit availability, bank loan availability, employment growth and investment growth are equal to one, if a firm reported an improvement/increase, and zero otherwise. Financial constraints with respect to credit/bank loans (FC) is equal to one, if a firm is credit constraint, and zero otherwise (the chart shows the inverse effect on the constraint, so a positive coefficient denotes a reduced constraint). The interest rate is the rate, charged on a credit line, which a firm applied for over the past six months (the chart shows the inverse effect, so a positive coefficient denotes a lower interest rate).. Confidence intervals are two standard deviations.
I refine my estimates and find that the effect is stronger for firms in the periphery of the euro area and smaller firms – those who need the most support. The impact of the PSPP is amplified by banks which hold a higher share of sovereign debt on their balance sheet or which are less capitalized.
The PSPP not only affects credit access, but also stimulates employment and investment growth of small firms. Hence, a quantitative easing programme is able to affect output and ultimately consumer prices, which is important evidence for an effective transmission channel of unconventional monetary policy. However, the analysis cannot identify to what extent banks tend to increase risk-taking by lending to more risky firms.
Bundesverfassungsgericht (2020), “ECB decisions on the Public Sector Purchase Programme exceed EU competences”, Press Release No. 32/2020, 5 May.
Funk, A. (2020), “Quantitative easing in the euro area and SME’s access to finance: Who benefits the most?”
Personal Website Anne Kathrin Funk
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How effective are foreign exchange interventions under inflation targeting? The case of Ukraine - by Anton Grui
Ukraine has been hit by no fewer than three crises in 2014–2015: a macroeconomic crisis driven by the annexation of Crimea and the military conflict in Donbass; an exchange rate crisis as the fixed exchange rate was abandoned in the face of growing current account imbalances and government budget deficits, fueling an inflation outbreak; and a banking crisis as oligarchic banking led to an increase in arrears and panic withdrawals of deposits. All three components intensified each other.
As the saying goes, “one should never let a good crisis go to waste”. After abandoning the fixed exchange rate regime, the National Bank of Ukraine (NBU) was reformed and moved towards inflation targeting (IT) with a floating exchange rate. Yet, many Ukrainians were gravely hit by the devaluation due to a large share of imported goods in a consumer basket and a high credit dollarization. Ever since, it is painfully hard to explain why a fixed exchange rate at 8 Ukrainian hryvnia per US dollar was bad and a floating exchange rate at 24-28 hryvnia per dollar is good.
The NBU thus finds it hard to ignore the exchange rate. Given the high public attention, it uses foreign exchange (FX) interventions as an additional monetary policy instrument with a view to smooth exchange rate volatility and accumulate international reserves. Many emerging market economies pursue IT, while also engaging in various degrees of exchange rate management. While a flexible exchange rate facilitates necessary price adjustments to changed external conditions or domestic fundamentals, erratic shifts in investors’ sentiments may also cause excessive exchange rate fluctuations, which become a source of economic disruptions by their own.
In a recent study (Grui, 2020) I assess the performance of FX interventions under an IT regime in Ukraine using a New Keynesian model with a modified uncovered interest parity (UIP) condition that accounts for the exchange rate management by a central bank. Specifically, I address two policy-relevant issues. First, to what extent is exchange rate management able to support price stability? Second, what is the effect of interventions on the exchange rate?
FX interventions in 2015–2020:Q1 were aimed at smoothing the exchange rate and, consequently, inflation. The model allows us to simulate the volatilities of the main macroeconomic variables if interventions had been larger, or had not taken place at all. The simulations show that moderately managed floating exchange rate has been on point to stabilize the economy.
Moderate amounts of FX interventions (as in 2015–2020:Q1) reduced volatility of both nominal exchange rate and inflation. Figure 1 shows the volatility of the exchange rate, interventions, the output gap, inflation and the policy interest rate under four alternative exchange rate policies (no interventions, moderate management, strong management, and a peg). Leaning against excessive exchange rate fluctuations is sensible in an open economy with high pass-through and not well anchored inflation expectations. Nevertheless, the exchange rate must remain floating in order to serve as an important economic stabilization mechanism. Its strong management could have led to more volatile inflation and policy interest rate.
Figure 1. Simulated standard deviations of main macroeconomic variables under various degrees of exchange rate management
Source: own calculations
Note: values are normalized for each variable to a baseline case of moderate exchange rate management
The model shows that interventions stabilize the exchange rate, as the FX interventions in 2015–2020:Q1 prevented the exchange rate from being 32% more volatile. Unsurprisingly, the stronger the exchange rate management, the more volatile the interventions are. The impact on inflation is contrasted. FX interventions in 2015–2020:Q1 stabilized inflation, but a more aggressive policy would have worked in the other direction. A similar pattern is observed with interest rate volatility that increases when exchange rate management becomes more active. A further 36% reduction in exchange rate volatility would have been associated with 8% additional inflation volatility and 32% additional policy interest rate volatility.
Output gap volatility demonstrates virtually no response to changes in the exchange rate management. Inelastic output undermines the monetary policy's ability to influence inflation through aggregate demand. Under such conditions, it is particularly painful to peg exchange rate and strip economy from yet another policy transmission channel.
2.Effect from interventions
Each additional dollar bought or sold by the NBU on the FX market influences the level of the exchange rate. The model interprets systematic deviations from the UIP as an effect of interventions. Comparing simulated effect of interventions to the actually observed series (and running an OLS) allows estimating the effectiveness of the latter (Figure 2).
Figure 2. Simulated interventions in comparison to actually observed series
Source: National Bank of Ukraine, own calculations
Note: a negative simulated effect of interventions means that the nominal exchange rate was strengthened; negative actual interventions mean that foreign currency was sold by the NBU on the market
Estimates indicate that FX interventions under IT have a strong and lasting effect on the nominal exchange rate in Ukraine. Additional dollar purchases by 1 percent of GDP in 2015–2020:Q1 weaken the exchange rate by 5.8% over the course of two quarters. The effect is assumed to be linear for both sales and purchases. In 2019 terms, USD 273 million are needed to nudge the exchange rate by 1% in a necessary direction.
Sterilized FX interventions under IT are influencing the nominal exchange rate three times more effectively than non-sterilized ones under the fixed exchange rate regime. First, heavy interventions may induce carry trade, which reduces their effectiveness. Second, interventions are not able to defend an exchange rate level forever in case of changed fundamentals. Instead, they should only address temporary shocks. Finally, effectiveness of FX interventions increases with better monetary policy credibility. It turns out that if a central bank does not guarantee any specific level of the exchange rate, it becomes easier to live to the promise.
Grui, A. (2020). Uncovered interest parity with foreign exchange interventions under exchange rate peg and inflation targeting: The case of Ukraine (No. 14-2020). Economics Section, The Graduate Institute of International Studies.
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Faiçal Belaid, PhD Economics
How bank lending boosts or impedes economic activity is a fundamental question in financial economic research, and has been assessed in many studies. In recent research, I focus on whether the link is different for young firms.
The key dimension through which the financial system impacts economic development is through the provision of external finance to new businesses or start-ups. Given start-ups’ role in enhancing employment growth, innovation, competition and exports, their financing has important implications for the economy. The two most common start-ups financing mechanisms are equity (internal finance) and bank debt. In underdeveloped financial systems with limited access to venture capital banks are the most important providers of external financing to start-ups. The use of debt by start-ups has significant implications for their profit performance, risk profile and the potential of the business expansion.
A situation where banks charge high interest rates for start-ups, reflecting a risk premium or rent-seeking if competition is limited can negatively affect their performance. Lending to start-ups can entail high lending costs (agency costs, monitoring costs and enforcement costs), leading banks to charge higher interest rates, thereby extracting a large share of start-ups’ rents. This impedes start-ups’ performance by squeezing down their profits and their market shares. Also, the higher cost of borrowing creates a financing barrier for start-ups. While the interest rate on loans is an input cost for all firms, we are interested in whether the impact of interest rates on profit is higher for start-ups than the one for existing firms.
I study the role of the Tunisian bank-centered financial system in financing firms at the time of creation. I find evidence that bank debt costs impede firms’ performance, and that this is more pronounced during the early stage of firms’ life cycle (the first five years of activities). Further, the impeding effect of bank debt on start-ups’ performance is relatively stronger for firms with low amount of collateral. My study finds that the weight of bank debt cost is more pronounced for new businesses than for existing firms which negatively impacts start-ups’ performance.
In countries where the financial system is bank-centered, banks can also take advantages of their monopolistic power and apply higher interest rates than what a competitive risk premium would warrant. This would impede firms’ development.
This study on the role of bank funding on new businesses development in an emerging economy complements the growing theoretical and empirical literature on firm’s capital structure. Policy makers should seek to develop alternative funding strategies for new businesses, such as venture capital. A state owned companies of venture capital could be one possible solution to promote this. Doing so will improve the sustainability of new firms and enhance jobs creation and economic growth.